A1259767834UuvLM

1
TRANSFER PRICING Navigating the Indian
Singapore waters!
Narayan Mehta Partner, Sudit K. Parekh Co.
25th May 2005
2

• An Overview of
• Indian Transfer Pricing Regulations

3
Transfer Pricing- an Introduction

• Denotes price charged by one related party to
  another for goods, services, etc.

• Objective To check the erosion of tax base and
  plug the leakage of revenue

4
An Illustration- Outsourcing
Contract for software development
Singapore Parent
Singapore Client
Singapore tax rate 20
Consideration _at_ S 35 per hour
100 Equity
Outsourcing Arrangement Consideration?? Transfer
pricing issues
Indian Subsidiary
Offshore software development
Indian tax rate -Nil
Need for balancing the Indian and Singapore
TP/ Tax regulations!!
5
Importance of Compliance

• Any related party transaction undertaken from 1st
  April 2001 onwards covered
• Currently 60 of worlds cross-border trade is
  between related parties- Indian tax authority is
  also going to be vigilant!
• UK for every 1 spent investigating transfer
  pricing cases, 120 was recovered in extra taxes
• Japan transfer pricing has been a major revenue
  churner- individual cases exceeds 100 m!
• US transfer pricing remains the topmost
  priority of IRSs agenda on international tax
• India - FY 01-02 assessments complete - Press has
  reported incremental tax revenues in excess of
  INR 50 million based on the first year of TP
  audit adjustments

6
Importance of Compliance

• No exemption from compliance
• Transactions exceeding INR 50 million to attract
  compulsory transfer pricing audit
• Onus of proof- tax payer primarily liable

• S.10A / 10B units- thin margin for error
• No deduction under section 10A / 10B on enhanced
  income!
• More than ordinary profits taxable not tax
  exempt!
• Adverse tax incidence for the Singapore parent
  outsourcing BPO operations to Indian entity
• Double taxation for the Group in respect of
  enhanced income

7
Importance of Compliance
Penalties are high !

• Addition to Income
• Failure to maintain documentation
• Failure to furnish documentation
• Failure to furnish Accountants Report

• 100 to 300 of tax on addition
• 2 of value of transaction
• 2 of value of transaction
• Rs. 100,000

Penalties are not tax deductible!
8
Importance of Compliance

• An effective tax planning tool to establish the
  appropriateness of transfer prices

9
Transfer Pricing- The Indian Perspective

• Income arising to Associated Enterprises from
  International Transactions shall be computed
  having regard to the Arms Length Price
• Indian regulations largely modeled on OECD
  guidelines

10
Legislative Framework
Associated Enterprise
International transaction
Legislative Framework
Income needs to be computed on an arms length
basis
11
Associated Enterprise

• Means direct or indirect participation in
  management, control or capital
• by one enterprise into another enterprise or
• by the same person in both the enterprises
• Either or both of Associated Enterprises
• should be non-residents

12
Associated Enterprise

• Deemed Associated Enterprises include
• Holding of 26 of voting power
• by one enterprise into another enterprise or
• by the same person in both the enterprises
• Dependence on intangible assets
• Sale of goods
• influence on price and conditions of supply by
  buyer
• Control by individual or his relative
• Loan transaction
• 51 or more of book value of total assets of the
  borrowing enterprise

13
Associated Enterprise

• Term of wide import - following parties also
  covered
• VC investors with 26 stake
• FIs advancing loans exceeding 51 stake of
  assets of borrowing enterprise
• Franchisers, licensees, technical collaborators,
  etc.
• Term of wide import- is your company covered?

14
International Transaction

• Means transaction between 2 or more Associated
  Enterprises
• For sale of products / other properties
• OR
• Affecting profits, losses, income, assets or
  liability of the enterprise

15
Arms Length Price

• Denotes price which is applied or proposed to be
  applied in a
• comparable transaction between
• unrelated independent parties in
• uncontrolled conditions
• Corresponds to the open market price

16
Computing Arms Length Price

• Arms Length Price to be computed as per
  Most Appropriate Method, to be selected out of
  
• Price based method
• Comparable Uncontrolled Price Method (CUP)
• Margin based method
• Resale Price Method (RPM)
• Cost Plus Method (CPM)
• Profit Split Method
• Transactional Net Margin Method (TNMM)

17
Comparable Uncontrolled Price Method or
CUP

• Compare price charged in a controlled transaction
  with uncontrolled transaction
• Adjustment for differences materially affecting
  the price is permissible

18
Comparable Uncontrolled Price
Method or CUP
3P-India
AE - Singapore
60 (internal comparable)
TP
60 (external comparable)
AE-India
60 (internal comparable)
3P - Singapore
3P - Singapore

• Price charged by AEIndia to AESingapore should
  be as per open market price
• 60 represents the open market price - Internal
  comparable preferable to external comparable

19
Resale Price Method (RPM)

• Reduce arms length Gross Profit Margin and
  procurement expenses from resale price of goods /
  services resold to an unrelated party
• Certain adjustments permissible

20
Resale Price Method
100
100 20
AE-India
AE - Singapore
3P - Singapore
3P-India
3P-Singapore
3P-Singapore
20 GP Margin on sales

• 100 The price at which sales made by
  AE-Singapore to 3P- Singapore
• 20 Gross Profit Margin identified from gross
  profit margin earned by Italian distributors on
  similar / comparable uncontrolled transactions

21
Cost Plus Method

• Add an arms length gross profit margin to the
  production cost of supplier providing goods /
  services to related purchaser
• Certain adjustments permissible

22
Cost Plus Method
100 15
AE-India
AE - Singapore
3P - Singapore
3P-India
3P - Singapore
3P - Singapore
15 GP Margin on sales

• Production Costs of AE-India 100
• 15 Gross Profit Margin on production costs
  earned by 3P-India on comparable sales made by
  other Indian software manufacturers

23
Profit Split Method

• Splitting the combined net profit of associated
  enterprises arising from international
  transaction between respective entities based on
  their relative contribution to the net profits

• Rarely used in practice

24
Transactional Net Margin Method

(TNMM)

• Comparing net profit margin of Associated
  Enterprise arising from international transaction
  with adjusted net profit margin for similar
  transaction with unrelated parties in comparable
  circumstances

• Similar to RPM / CPM

25
How methods are chosen in practice?
Most Appropriate Method ??? ??? ?
Cost Plus
Profit Split
TNMM
Resale Price Method
Comparable uncontrolled price
Other Yet to be prescribed
26
Computing Arms Length Price-

summary

• Selection of the most appropriate method
  relevant factors
• Business model and organizational structure
• Functional and risk profiling of related parties
• Contractual terms
• Nature of products and services

27
Powers of Indian Tax Authorities

• Powers to
• Call for information
• Determine Arms Length Price
• Determine total income having regard to Arms
  Length Price
• 5 difference allowed
• No deduction under section 10A / 10B / 80HHC on
  enhanced income!
• Corresponding adjustments not permitted !
• Permitted under certain Indian Treaties!
• No adjustment to withholding tax!
• Compulsory scrutiny for transactions exceeding
  INR 50 million

28
Transfer Pricing Assessment
TPO will review compliance by the tax payer with
the arms length principle
TPO will make further enquiries
?
?
Does the TPO agree with the views of the tax payer
No
Yes
Taxpayer given an opportunity to respond to TPOs
position
TPO would pass a favourable order in relation to
the international transaction examined
TP Adjustment
Has the taxpayer responded with sufficiently
detailed facts arguments to enable a
re-evaluation of TPO position
?
?
No
Yes
TPO re-evaluates his position
Does the TPO now agree with the taxpayers
position
?
No
Yes
?
29
Documentation- why necessary?

• To be better prepared for transfer pricing audit
• To support your arms length price in future
• Especially important in loss situations

The tax authorities will never understand your
business as well as you, therefore Effective
communication of your TP policy is critical!
30
Documentation- fixing the jigsaw
puzzle!
Accountants Report
Documentation
Agreements
Functional Analysis
Benchmarking
Industry Analysis
31
Primary Documentation required under Indian
Regulations

• Associated Enterprise related documents
• Transaction related documents
• Description of functions performed, risks assumed
  and assets utilised
• ALP computation related documents
• Record of transactions considered for determining
  price of international transactions
• Analysis performed to evaluate comparability
• Description of all methods considered and reasons
  for selection of the most appropriate method
• Record of actual working for determining arms
  length price
• Details of comparable data used in applying most
  appropriate method

32
Secondary Documentation required under Indian
Regulations

• Government publications, reports, studies,
  databases
• Market research studies and technical
  publications of recognized national or
  international institutions
• Price publications including stock exchange and
  commodity market quotations

• Relevant agreements and contracts entered into
  with associated enterprises or with unrelated
  enterprises
• Letters and correspondence documenting terms
  negotiated with the associated enterprise

33
Indian Documentation

• No need for fresh documentation every year
• Requirement for filing of CAs report
• 31st Oct/31st July

34
Summing Up
Indian Income-tax Act, 1961 Transfer Pricing
Regulations
Arms length price
Documentation
Accountants Report
35
Compliance and Certification
Timeline
April 1st 05 March 31st 06 Oct 31st 06 Oct 31st 07 March 31st 09 March 31st 15
36
Thank You
Contact Narayan Mehta Tel 91 22
22821141 Fax [phone] Mobile 91
9820544495 E-Mail narayan.mehta_at_skparekh.com
?

• Queries